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Monday, January 05, 2009

Government spending vs the recession

An interesting observation in the Economist: recessions aren’t as bad as they used to be.

Even before the Great Depression, downturns were typically much deeper and longer than they are today [and, conversely, booms were more spectacular – TF]… One reason why recessions have become milder is higher government spending. In recessions governments, unlike firms, do not slash spending and jobs, so they help to stabilise the economy; and income taxes automatically fall and unemployment benefits rise, helping to support incomes.

The article adds:

A recession triggered by tight monetary policy can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression caused by falling asset prices, a credit crunch and deflation, conventional monetary policy is much less potent than fiscal policy.

All of which suggests that letting public borrowing shoot up over the next year or so is the lesser of two evils. Cant about a “debt crisis”, while satisfyingly moralistic, is beside the point in deciding what to do now.

2 comments:

Chris
said...

Regarding the cant, I don't think it is even satisfying, especially given the source. There was a paragraph in this Anatole Kaletsky mea culpa that stood out for me in this regard.

As a result of moralistic witch-hunts against debt and consumption, pragmatic Keynesian solutions to the credit crunch have been thwarted by an unholy alliance of ideological monetarists who believe that the market is always right and ideological Marxists who believe that it is always wrong. Even worse, consumers and businesses have started to see recession as a moral retribution for past excesses, rather than a technical problem that macro-economic policy could - and should - readily resolve.

In my opinion there are better reasons to explain the change, including:- We now have nuclear bombs meaning there can not be any major conflict anymore. Wars have a major impact on economies, government spending and inflation, etc.- Together with the absence of wars, we have less international rivalry and less protectionism. Before WW2, economic downturns often led to more protectionism.- Other changes in the economy, such as the switch from manufacturing to services.